If you have a balance on a high-interest credit card and are looking to pay it off, balance transfers are a good idea. There are many credit cards out there that even offer promotions to get you to open an account and transfer your debt.
For example, some offer up to two years to pay off your debt interest-free. Others waive balance transfer fees to make it even more inexpensive to move your debt.
But while balance transfers are a great way to pay off debt fast, they can harm your credit if you’re not careful.
Here’s how balance transfers affect your credit score
Similar to just about everything credit-related, there’s no way to know for sure exactly how your balance transfer will impact your credit score. There are a few different factors that go into that calculation:
- How much you’re transferring
- The credit limit on your new card
- Whether you open or close an account to do the transfer
- How long it takes you to pay down the balance
Now, let’s go into detail for each factor.
How much you’re transferring
While it’s normal to transfer debt from just one card to a new one, some banks allow you to make multiple transfers from different banks. Depending on how much debt you have on multiple cards, moving it all into one place can spike your credit utilization.
“Credit utilization is a part of your credit score calculation and is defined by the amount of credit you use as compared to your credit card limits,” says Wendy Moyers, a Certified Financial Planning™ professional.
For example, say you have the following credit cards:
- A Card: $3,000 balance / $10,000 credit limit
- B Card: $1,000 balance / $5,000 credit limit
- C Card : $500 balance / $2,000 credit limit
“After timely payment, the credit utilization ratio is the second highest factor in calculating your credit score,” says Moyers. “The ideal credit utilization ratio is below 30%,” both on each card and across all cards combined.
For the above cards, your credit utilization would be as follows:
- A Card: 30%
- B Card: 20%
- C Card: 25%
- Combined: 26%
As you can see, all of these are at or below the recommended threshold. But if you transfer all of those balances to a new card, your credit utilization on the new card could spike. Of course, we need to know the credit limit on the new card to know for sure.
Calculate how much debt you currently have, then consider the next factor.
The credit limit on your new card
Now that you know how much debt you have look at the credit limit on the new card you’re transferring your balances to. In this scenario, let’s say Card D has a credit limit of $7,500.
If you were to transfer all three balances, you’d have a $4,500 balance on the new card, giving you a credit utilization of 60%.
Of course, this is counteracted a bit by the fact that you now have a 0% utilization on the other three cards. But your credit is still likely going to take a hit with the new high balance.
Whether you open or close a card to do the transfer
Every time you apply for a new credit card account, the hard credit check the lender does during the application process can knock a few points off your credit score. What’s more, adding a new account immediately lowers the average age of all of your accounts.
Since the length of your credit history is one of the factors that go into your credit score, a lower average age of accounts can have a negative impact on your credit score.
Closing a credit card can also negatively impact your credit score. That’s because by closing it, you no longer have that available credit to help lower your aggregate credit utilization.
How long it takes you to pay down the balance
While transferring a balance can spike your credit utilization, that doesn’t mean the impact on your credit score is lasting.
In fact, your credit utilization is calculated on a monthly basis. So, if you do the transfer in one month and pay off the entire balance the next month, your credit score will bounce back immediately.
If, however, your balance transfer results in a high credit utilization and it remains high for months while you pay down the balance slowly, the negative effects on your credit score will remain in place until you get the balance down to a more favorable level.
So, is a balance transfer worth it?
Although doing a balance transfer can hurt your credit score, it’s important to weigh the costs of the interest you’re currently paying against the negative effects. If you have high interest rates and big balances, transferring your debt to a card with a 0% APR promotion for balance transfers can save you hundreds of dollars, if not thousands.
Also, consider whether you’re planning on applying for credit in the near future. If you’re not, it doesn’t matter if your credit score dips for a few months. Once it gets back to where it needs to be, you’ll be in good shape again. That said, it’s important that you run the numbers before applying for a balance transfer card.
The more time you spend planning your balance transfer, the easier it will be to get as much value with as little negative impact as possible.
“Recognize that each of these actions may also affect your score, so it is important to be careful what solution you decide,” says Moyers. “The most important decision being to reduce your credit card as much as possible.”
Ben Luthi is a personal finance writer and a credit cards expert who loves helping consumers and business owners make better financial decisions. His work has been featured in Time, MarketWatch, Yahoo! Finance, U.S. News & World Report, CNBC, Success Magazine, USA Today, The Huffington Post and many more.